It's looking more and more like reports of the disastrous effects of competition that were to befall the debt collections industry were way overdone. The first hint came last week when Motley Fool Hidden Gems selection Portfolio Recovery Associates (NASDAQ:PRAA) announced that enough debt was available for it to repurchase at attractive prices that it would not only put its operating cash flow to work, but also tap its credit line.
Tuesday, AstaFunding (NASDAQ:ASFI) released its fourth-quarter earnings and told a similar story, which is more good news for the industry. Quite simply, because of the influx of bankruptcy filings before the law changed in October, there is more debt being charged off by credit card companies and other debt holders than initially expected. This is certainly good news for the collections industry, which has had a smaller supply of bad debt to work with and more bidders for it. However, this surge in bad debt due to the change in the law is temporary, and eventually the increase in available paper should taper back to normal levels. In which case being a solid and disciplined operator will become more important.
After reading through the transcript for the company's conference call, I think that in the long term Asta Funding should do well because it's disciplined in its purchases, collections, and in some cases sales of debt. Perhaps the most important part of the three is how much the company pays for its paper and the quality of the paper. In addition, Asta's lean business model allows it to be flexible during slow times and ramp up quickly during busy times, because it relies a great deal on third parties for the actual telephone call and direct mail collection activity.
For full-year fiscal 2005, that outsourcing model led to diluted earnings per share growth of 36.9% and a dividend increase of 14%. So far this quarter, the company has also purchased $970 million in face value of debt for $48 million (i.e., a little less than five cents on the dollar) and, like Portfolio Recovery Associates, it sees other purchases on the horizon.
Investors liked the news of Asta Funding's brighter prospects, bidding its shares up more than 3.5% in Tuesday's midday trading. Despite today's price run-up, the company's shares still look reasonably priced, particularly when you consider the long-term growth rates of bad debt collections and the leanness of Asta's business model. The same can also be said for Asset Acceptance Capital (NASDAQ:AACC) and Encore Capital Group (NASDAQ:ECPG); I haven't spent as much time looking at them as I have Asta Funding and Portfolio Recovery. But, based on valuation, both are interesting and worth some time researching.
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Nathan Parmelee owns shares in Portfolio Recovery Associates, but has no financial stake in any of the other companies mentioned. The Motley Fool has an ironclad disclosure policy .
